This article is sponsored by Bridgepoint Credit
With greater innovation, more sophisticated analysis techniques and higher expectations among LPs, fund managers are raising the bar when it comes to environmental, social and governance based approaches. Private Debt Investor spoke to Bridgepoint Credit’s Alex Hökfelt, managing director, and Cathy Wang, vice-president, about what this means for the future.
If you think about the evolution of responsible investment techniques and strategies in recent years, where do you believe the industry has seen notable innovation, specifically in relation to private debt?
Cathy Wang: Innovation in responsible investment has been significant in recent years. If you go back even five years, you can clearly see that ESG was not a major consideration. If anything, it was a niche product. Today, LPs and investors now regard ESG as an investment criteria and no longer as a niche, aspirational goal.
What evidence is there of the industry embracing closer collaboration and recognising the growing demand among LPs for considered approaches to ESG and impact within investments?
CW: We have seen the emergence of associations and organisations formed specifically to focus on and create agendas within ESG and responsible investment more broadly. As a result, ESG is now a recognised factor to be assessed across credit investments. One of the associations which has been actively engaged is the European Leveraged Finance Association. One of their recent agenda focuses was a questionnaire of ESG topics in order to highlight priorities to leveraged loan issuers. This is a prime example of how the use of ESG measurement is fast becoming the norm.
Alex Hökfelt: We recognise the value in collaboration and believe that learning from each other and sharing experiences is always a good thing. For example, I am doing a workshop with a group of general market participants which has been designed to strengthen our capabilities in making ESG disclosures.
Historically, there wasn’t always a great deal of collaboration within this market, but that is starting to change. As Cathy says, ELFA are working hard to get people around the table. There are also conferences such as the Responsible Investment Forum, which bring together institutional investors, investment managers and market participants to discuss broader ESG issues across alternative asset classes.
How should today’s investors consider ESG and weigh up what they consider to be material responsible investment themes?
AH: Most investors will have a screening policy which will allow their institution to take a decision on the sectors that they will finance and those that they will not. We have developed a framework that looks deeper, at solutions provided by the company but also its internal practices.
This framework allows us to measure the impact that a company has on society and the environment through the solutions that it provides. This can be measured by looking at the sector, or sub-sector, in which it operates. Crucially, our framework also considers the set-up from a governance perspective, looking at the policies and procedures in place and their individual approach to governance.
What do you consider to be critical to understanding the ESG profile of investments when building a portfolio?
CW: Alex and I have been working on fully assessing our portfolio. It is important that we are comfortable with the ESG aspects of our portfolio and to ensure there is no form of negative impact on the environment or to society from the companies to which we lend.
“LPs are quite rightly sensitive to even minor negative exposures and will have certain sectors they simply don’t want to be associated with”
AH: Ultimately, we are striving to have a portfolio that has a positive impact on society. It is hard to score ESG precisely, but we believe our framework indicates that our credit portfolios as a whole are positive in terms of ESG impact.
Unlike holders of equity, private debt investors have limited tools with which to engage and hold companies to account. What does this mean for ESG approaches?
CW: Yes, there is a difference with controlling equity holders who contribute to a portfolio company’s strategy, unlike private debt providers, who don’t control the underlying asset. Instead, we offer a solution from a financing point of view but have no direct influence on the governance of the company, so our ability to set ESG strategies is more limited.
What we can do is make sure we consider the relevant ESG metrics that we believe to be important when we assess individual situations. When we are in discussions with sponsors and management teams, we do raise questions during the due diligence process and follow-up on our findings. As a credit investor you are also able to factor in ESG by having a very clear idea of the sectors and industries in which you would like to be invested.
AH: By having a framework to assess individual ESG matters, it allows you to take a view on the asset. You can then seek to encourage, support and potentially influence management teams and sponsors. By making ESG a part of the due diligence process and the regular dialogue, it starts to make a difference to how seriously it is taken.
And what about the LPs? How do their views manifest in discussions with you and your colleagues?
AH: LPs are quite rightly sensitive to even minor negative exposures and will have certain sectors they simply don’t want to be associated with. That’s why you have to be innovative and try new things, as we have done with our framework. LPs are continuously challenging us to focus on ESG and we welcome that challenge.
How would you say investor attitudes have changed with regards to ESG?
AH: Investor mentality has shifted. ESG is a topic that is front and centre for investors. We all realise that companies with a strong ESG focus are better companies and tend also to have a better risk profile. Companies that score well on ESG should see a positive impact on the value of the business.
So, would you say LP sophistication has increased with regard to ESG and responsible investing?
AH: It depends on the investor. I think it is fair to say that some investors have always been focused on ESG, whereas other LPs have not necessarily always had it front of mind but do now.
Those who are more mature in their understanding of ESG are much clearer about what they want and also what they don’t want in their portfolio. Some are super-focused on it, in fact.
With such an abundance of data now available to measure ESG, what do you consider to be the best approach?
CW: The use of external data sets is something we are currently thinking about. Traditionally, we have used in-house data, such as the information we obtain from our questionnaire we use for our deals. This tends to be our primary data source, where we make an assessment from an ESG perspective.
“LPs and investors now regard ESG as an investment criteria and no longer as a niche, aspirational goal”
During our due diligence process, we will usually get access to senior management. However, within Bridgepoint Credit, we do a host of different things. This includes senior debt, direct lending and opportunistic credit. Each of these areas will have variations in approaches with regards to the access we get to information as well as the primary access to management.
The other factor I would highlight is the assessment of a company’s governance practices. For example, we think it is important to ensure that company boards have proper checks and balances in place, including independent representatives.
Do you expect to see a change in the client profile of your business as a result of changing attitudes towards ESG?
AH: We haven’t as yet, but fund lives are long. In the next couple of years, we will know. I am confident that we will attract more investors because of our focus on ESG.
What do you consider to be the major ESG or responsible investment themes that you encounter frequently at the moment?
CW: If we break down E, S and G, the “E” element is probably the most straightforward one. We have reviewed several companies in the past who, on paper, presented attractive credit stories but during the due diligence process were assessed to have a negative impact on the environment. Obviously, that can also have a detrimental impact on the social well-being of the local communities. So, clearly, they wouldn’t be the type of businesses that we would want to get involved with because of certain thresholds we have set in our process.